Saturday, August 30, 2014

IRS Wins a Horse Case for a Change

Originally Published on on January 30th,2012
The poster child for a business activity that the IRS will consider a hobby, denying deduction of net losses under Code Section 183, is horse breeding.  Horse breeders often do OK in Tax Court though.  I think Tax Court judges share my attitude.  Horses are large animals that seem to defecate quite a bit.  How much fun can caring for them be ? Although the Tax Court had a fairly extensive analysis of Peter and Carolyn Bronson’s Coldstream Farm, where they raise Welsh ponies, I think an off-hand observation may have been critical:
Moreover, because petitioners’ horses were all boarded during the years at issue, they essentially avoided the unpleasant tasks associated with caring for horses, such as cleaning stalls, regular exercising, and the like.
The years at issue were 2001 to 2005 with deficiencies averaging almost $30,000 per year.  Peter Bronson is an attorney.  Carolyn Bronson, whom the Court refers to as Dr. Bronson, by virtue of her Ph.D. in consumer finance, devoted her time to the Welsh pony business.  They had become interested in Welsh ponies when their daughter began riding lessons on one.  Apparently they had a no change audit in 1999.  Due to the high cost of boarding, they had determined that they would not be able to be profitable without their own facility. 
One of the keys in winning a hobby loss case is that you show the Court that you were paying attention to your results and modifying based on experience to get more profitable, even if you are ultimately unsuccesful.  The Bronson’s plan to buy their own place indicates that type of thinking.  However, they took a long time to do it, which might be a sign of prudence, but during that time they continued to acquire more ponies.  That seems to have been the Court’s greatest criticism of their profit motive.
The Court also had some issues with record keeping:
Finally, petitioners claim that their recordkeeping indicates a profit motive because they “always recorded every business-related expenditure individually, and have assiduously separated business-related from non-business components of even $5 and $10 expenditures.” A close examination of their records reveals a different picture. For more than three-quarters of the expenditures that had mixed horse activity and personal components, petitioners simply allocated exactly 80 percent of the expenditure to the horse activity, suggesting that their segregation of nondeductible personal expenditures was, at best, approximate. We also note that the depreciationschedule attached to petitioners’ 2002 return lists a dog among the depreciated items, and petitioners deducted $1,144 of Schedule C expenses relating to the dog in that year. In short, petitioners’ recordkeeping was not businesslike; personal expenditures were not meticulously segregated as petitioners claim.
The dog almost inspired a bad joke on my part to the effect that since they were small horses, a really big dog might pass.  Aren’t you glad I skipped that?  Another CPA who knows more about horses and dogs, for that matter, than I do, indicated that it is possible that they were using the dog to herd the horses.  She thought it a stretch, but plausible.
Although they used an accountant to prepare returns, the Court did not think that they adequately consulted with him on the hobby loss issue so they got hit with penalties for two of the years.  Peter Bronson is an attorney specializing in bankruptcy litigation.  He and Dr. Bronson represented themselves.  The deficiency was close to $150,000 so I have to question whether that was good judgment.  Another possible error was claiming a bargain sale charitable deduction on the sole horse that they sold during the five years.  To me that is a “Hogs get slaughtered” type of maneuver.
If you have been deducting persistent losses from a horse breeding activity, you might want to contrast this case with that of Mark and Patti Blackwell.
You can follow me on twitter @peterreillycpa.

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